There were many perspectives and ideas shared at the recent Ri$kMinds event in Geneva. Here are a couple of the notable quotes from regulatory and banking executives:
Financial innovation: “We need a more formal process to distinguish healthy innovation versus arbitrage“ ~ Jose Maria Roldan, Banco De Espana
Safety and soundness: “We need to raise the resiliency of all banks“ ~ William Coen, Basel Committee on Banking Supervision
How much capital is enough: “There needs to be agreement on the question of ‘how much’ if banks are to properly make their contribution and meet their accountabilities and obligations to the societies and economies in which they operate.” ~ Alan Smith, HSBC
On the last point, it is my opinion that we will see greater agreement between regulatory authorities and financial institutions on how much capital is required. We’ll get there through a deeper understanding and more accurate quantification of lending risk - made possible by sourcing of additional data, simultaneous holistic classification and aggregation of risk estimates, and improvements in risk modeling. This has direct implications for improved ABS pooling methodology, risk disclosure and rating, which is the subject of some recently published work spearheaded by Mingyuan (Sunny) Zhang.
Greater regulation, but choices remain
There certainly is no disputing that the financial services industry today is subject to far greater regulation and oversight at an institutional, country and systemic level. That said, I am detecting a growing shift from pure compliance to more competitive uses of risk information and analysis.
New capital requirements may constrain overall risk exposures, but companies can choose the mix of necessary and sufficient financial assets and funding sources to ensure they achieve their overall return targets.
This includes not only taking and maintaining capital markets positions for traded financial instruments, but also evaluating and adopting strategy relative to which business to grow or downsize. Those decisions are critical to achieving the right portfolio mix of customer-based assets – which makes up the largest share of interest and fee income for banks. This sort of decision-making is, of necessity, information-intensive and analysis-based. Definitely not “back-of-the-napkin” exercises!
Further, the concepts of stakeholder risk appetite (the amount of risk an organization is willing to accept in pursuit of its business objectives) and risk tolerance (acceptable degree of variance from the appetite) are central to any risk-based decision process. To anticipate what might happen relative to liquidity, counterparty exposure, asset values and a host of other concerns (including the worst that could happen), decision-makers can utilize stress-testing, reverse stress testing and stressed VaR, coupled with advanced economic and time series forecasting, Monte Carlo simulation and optimization. There were many successful applications of these, and other analytical techniques, shared at the conference.
Increasing role of technology
What continues to emerge post-financial crisis is movement toward a more holistic and integrated risk management program at financial institutions. This is being driven by desires to streamline operations, reduce costs, speed delivery, avoid surprises and better price risk. In addition, competition is getting fiercer, funding spreads are about as narrow as they get, public trust of banks has been slow to recover, regulatory scrutiny has ramped up significantly and the recession has dragged on. Banks, and other financial institutions, realize that this is no time to sit back and try to weather the storm. The choices made today will sow the seeds for success or failure tomorrow.
President Obama has put forth a Strategy for American Innovation, in which he makes the case to the American people that innovation is a primary pathway to better times. Technological innovation represents an important area where corporate executives can turn to for help.
Financial institutions want to be more pro-active, and recent breakthrough technology can boost their ability to do so.
More specifically, operating results, balance sheet planning and business strategy need to be combined in meaningful ways to surface important concentrations, co-dependencies, gains, gaps and trends. The supporting processes for this holistic performance and strategy analysis must enable increasingly swifter and more reliable delivery. In the world of high-finance, timing can be everything, and advance notice goes a long way toward ensuring successful strategy execution. High performance analytics, in addition to management of big data, can really help firms on both fronts, by anticipating market adversity and also by identifying opportunity. Both are key ingredients to a top-tier risk management program.
NOTE: Originally published on The Principled Achiever.